Drawbacks of using budgets

Can be certain undesirable consequences that occur if budgets are too rigid. Factors that may affect the efficacy of a budget include:

Incorrect allocation - A budget that is too generous may encourage inefficiency. A budget that is insufficient will demotivate staff and hinder progress through a lack of money for example NHS

External Factors - Changes outside the bidget holders' control may affect their ability to stick to the plan

Poor communication - Budgets must be agreed between people who understand the area in question and also other factors that might influence the budgets

Budgetary control - The establisment of the budgeted and the continuous comparison of actual and budgeted results in order to ascertain variances from the plan and to provide a basis for revision of the objective or strategy

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Variance Analysis

A variance represents the difference between the planned standard and the actual performance.

*If the variance reveals a poorer performance than planned, it is known as an adverse or unfavourable variance, eg higher costs or lower sales revenue.

*If the variance shows a better performance than planned it is known as a favourable variance, eg lower costs or higher sales revenue

A variance can be caused by changes in

storage and wastage of material

material costs (cheaper or dearer)

efficiency changes

morale and efficiency of staff

wages

quality of material

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Improving cash flow

Too much cash means a firm will have less machinery and stock than it can afford and so makes less profit

Too little cash will threaten survival if a bill cannot be paid

In order to maintain the right balance, a firm plans its cash holdings by compiling a cash flow forecast

This enables the organisation to identify potential problems and take appropriate action (eg arranging a bank overdraft)

Only way to solve a cash flow problem is increase sales revenue or reduce costs

Causes of cash flow problems

Over investment in fixed assets leaving no money to pay bills

Over trading producing too many goods and running out of cash

Management errors - poor market research or budgeary control leading to cash shortages

Seasonal factors - low sales revenue or high costs during part of the year eg ice cream

Credit sales - increasing sales & thus expenses, but with no cash received until a later date

Stockpiling - tying up assets in stock

Changing tastes - products do not sell

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Methods of improving cash flow

Bank overdraft- only for short term

Easy to organise

Very flexible

Often cheaper than a loan bc interest is only paid only on the amount overdrawn and the time the overdraft is used

Interest rates are flexible, making it difficult to budget accurately

The rate of interest charged on a overdraft is usually significantly higher than that of a short term bank loan = more expensive

Short term loan/bank loan

Fixed rate of interest, simple to budget for loan repayments

Cheaper solution than an overdraft as interest is less

Can be used for a specific amount of time to suit the needs of the business

Interest is paid on the whole of the sum borrowed even if the business can repay the loan earlier a loan penalty charge may be imposed

Business will need to provide the bank with security (collateral) in order to secure the loan

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Methods of improving cash flow

Factoring - is when a company usually a bank buys the rights to collect the money from the credit sales of an organisation (selling off your debts)

The firm gains improved cash flow in the short term

Administration costs are lower bc the factoring company chases any bad debts

Reduced risk of bad debts

Main problem is the cost to the business, which will lose between 5%-10% of it revenue

The factoring company will charge more for factoring than it would for a loan

Customers may prefer to deal directly with the business that sold them the product

Sales of assets- short term

The sale of fixed assets can raise a considerable sum of money, particularly in the case of large asset ie a building

Sometimes the asset may no longer be needed and is adding unnecessarily

Assets such as buildings & machinery may be difficult to sell quickly

Fixed assets enable a firm to produce the goods & services that create its profit

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Methods of improving cash flow

Sale and leaseback of assets

This will overcome the cash flow problem by providing an immediate inflow of cash usually of quite a significant level

Ownership of fixed assets can lead to a number of costs, ie maintenance. For leased assets, the company leasing them does not have to pay these costs

Owning an asset can distract a business from its core activity

The rent paid is likely to exceed the sum received, eventuallly

The firm now owns fewer assets that can be used as security against future loans

The business may eventually lose the use of the asset when the lease ends

Integration opportunities:

Controlling stock carefully to reduce the costs incurred in holding in too much

diversifying its product portfolio to create a range that sells throughout the year

Anticipating change beter through improved decision making procedures, planning, monitoring and control and more thorough market research and intelligence.

Setting aside a contingency fund to allow for unexpected payments or cope with lost income.

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Distinction between cash and profit

Cash = money coming into the business in the form of sales revenue

*HOWEVER not all that cash turns into profit as the business has to pay for the costs of sales and other overheads *

Sales revenue - costs = profit (net profit)

Short term - positive cash flow is the most important factor

A business can look very profitable on paper but until that money is received the liquidity of the business may be threatened eg if the business still has to pay suppliers for raw materials up front but there is a delay to receiving money for the finished goods off the customer.